Air NZ's earning recovery prospects looking good

Air New Zealand's first Boeing 787-9 was tested in the
skies above Seattle, Washington, this week. Photo by AirNZ.

Air New Zealand, whose first Boeing 787-9 took to the air
for the first time on Thursday, is expected to continue its
earning recovery through 2014 and 2015.

Morningstar broker Scott Carroll said the New Zealand
national carrier was expected to benefit from strategic
alliances, fleet efficiency improvements and route
rationalisation in long-haul.

Alliance benefits could take up to two years to fully
materialise as scheduling and marketing arrangements were
fine-tuned, he said.

The proposed alliance with Singapore Airlines on the
Singapore-New Zealand route could deliver upside in the
immediate future, if regulatory approval was secured.

''The alliance will significantly improve the airlines' Asian
network and frequency to the region and offer new revenue
opportunities from passengers flying to onward destinations
with the partner.''

The Boeing 787-9 completed its first production test flight
above Seattle, Washington on Thursday.

The aircraft, which was in Air New Zealand's signature black
livery, is currently in the final phases of the delivery
process before being formally handed over to the airline as
the new owner. Air New Zealand is the launch customer for the
Boeing 787-9 and has 10 of the stretch versions of the 787 on
order.

This first test flight is known as a B1 flight where the two
pilots put the aircraft through its paces thoroughly
exercising its systems to verify performance while at the
same time the functionality of every aspect of the cabin is
tested in-flight.

Morningstar had raised its fair value estimate for Air NZ
shares to $2 from $1.80. The change reflected a lower assumed
cost of capital for the business, Mr Carroll said.

Morningstar had previously applied a weighted average cost of
capital (waac) on Air NZ above its Australian peers.

''We now believe this is unjustified given the strong
operational performance of the business and its dominant
competitive position in the New Zealand market.''

However, a possible risk remained a reinvigorated Jetstar
could aggressively add capacity to the New Zealand market.
Airline duopolies could still be highly competitive, he said.

Morningstar retained its ''no moat'', or competitive
advantage, rating for Air NZ, reflecting the competitive
nature of the airline industry, minimal barriers to entry and
low switching costs.

Airlines were capital-intensive businesses requiring ongoing
fleet investment that could hinder returns. Historically,
long-term returns in the airline industry had been poor.

For Air NZ, capital expenditure was expected to remain high
through to the 2016 financial year with spending on new
aircraft, including the wide-body Boeing 787s.

''Although we are supportive of the strategy outlined by
management, we continue to expect long-term returns to be
below Air NZ's cost of capital,'' Mr Carroll said.